1. Inflation targetting: Buying an outdated policy

Inflation targetting: Buying an outdated policy

Inflation-targetting is a bad idea, and will hit govt

By: | Updated: March 3, 2015 1:14 PM
Inflation, Inflation targetting, Narendra Modi, Arun Jaitley, RBI, RBI infaltion Narendra Modi has refused to embrace the idea of keeping the currency weak in order to boost exports, Arun Jaitley has decided to accept the idea of an inflation-targetting central bank. (AP)

While Prime Minister Narendra Modi refuses to embrace the perfectly sensible idea of keeping the currency weak in order to boost export in the manner that China has done for decades, Finance Minister Arun Jaitley has decided to accept the idea of an inflation-targetting central bank, an idea long past its expiry date. Indeed, in countries like the US, the central bank looks at a series of indicators like the joblessness rate, not just inflation data. This, in fact, is the model that India has followed for years and which, till recently, delivered good results – the model failed to deliver as RBI didn’t see the warning signs on inflation, but that is easily fixed. Given the collapse in inflation levels, it is likely Jaitley doesn’t see the danger in what some of his advisors have been pushing him to do since he came to office. The problem is that, as inflation starts rising, RBI will be forced to keep interest rates high. Indeed, just the fact that an inflation-targetting RBI kept interest rates high for several months – even though inflation-targetting had not been adopted till now, RBI has been informally been adopting it – should have alerted Jaitley to the dangers of formalising the policy. Indeed, given the role of structural factors (lack of a unified national agriculture market) as well as seasonal ones (too much or too little rain) in exacerbating inflation, it is likely interest rates in India will remain elevated – this will hurt industry and services while not being able to influence inflation that occurs due to supply-side reasons.

Apart from the problems associated with a central bank single-mindedly focussed on inflation to the exclusion of all other variables like growth, the monetary policy framework will sharply bring into the open RBI-government fissures. During the period when Duvvuri Subbarao was Governor, RBI often criticised the government for not holding its side of the bargain. So, RBI would talk of the expansionary fiscal policy and of policies like the minimum support prices that were driving up rural, and hence urban, wage inflation; and of the supply-side bottlenecks that were keeping the supply response low and causing inflation to spiral. With RBI now mandated by law to keep prices within a band, the central bank will have to give a written explanation as to why it failed to do its job. So, expect formal RBI reports, complete with econometric proof, to show how the fiscal overhang made its job impossible, or how the higher MSPs for rice were responsible for inflation rates. Just last week, the finance minister decided to give the fiscal targets under the FRBM the go by – the FRBM target of 3% for FY18, it has to be remembered was last fixed at this level for FY08 – in order to stimulate government capital expenditure in the absence of the possibility of any step up in private sector investments due to extremely leveraged balance sheets. Under the new policy, just as RBI will be held accountable for keeping to inflation targets, the government will have to hold its end of the bargain on the fiscal side. It is fair to wonder if the finance minister failed to appreciate this or whether he, in fact, wanted an external check on government spending as well as other policies.

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  1. G
    Mar 3, 2015 at 12:54 pm
    Inflation targeting indeed promotes fiscal discipline, which in turn gives confidence in the overall management of the country's finances. I would like to think that Mr. Jaitley would like to improve investors confidence in economic management to attract domestic and foreign investment and to improve country's compeiveness to raise exports and employment. There will be no need to seek a depreciation of Rupee if India can do real sector reforms to increase compeiveness and investment. Further, currency depreciation cannot be sustained because eventually it will induce capital outflows. Thus, the policy of depreciation will require regressive controls on balance of payments flows, resulting in inefficiencies, corruptions and lower economic growth.
    1. S
      Mar 3, 2015 at 3:38 pm
      While Inflation targeting is extremely dangerous,as it merely imitates he US Federal Reserve and other developed economies like an,UK and Eurozone,to have a huge Debt,cancel it with QEs and service it with ZIRP,NIRP and low interest rate regime repeated ad infinitum,thus confiscating the wealth of the Citizens,the author is wrong as his recommendation, will make Indians with NO TANGIBLES poorer and increase the rich-poor gap. India is huge economy and nation and look inwards instead of exports,but alas! India is now in the firm grip of G 20[which is conquest of nations without war,by the likes of the dangerous and suspctedly predatory BANKER,but nonchalantly masquerading as the saviour of the poor,the IMF]. The present leaders are like the UPA, will make India Greece of 2014,and have handed INDIA OVER TO THE EAST INDIA CO Ii

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